When choosing from the thousands of US-listed exchange traded funds (ETFs), cost is a central focus. And it should be: High costs erode portfolio returns.
As investors and financial advisors seek to identify funds that are well suited to meet portfolio objectives, minimizing costs is an important part of the investment decision process — and expense ratios play a critical role.
The expense ratio of an exchange traded fund reflects how much it costs to operate an ETF.
The expense ratio is typically expressed as a percentage of a fund’s average net assets and can include various operational costs and annual fees, such as:
These operational expenses impact the fund’s net asset value (NAV). The NAV of an ETF represents the per-share value of the fund's assets less any liabilities, such as operating expenses.
The expense ratio doesn’t include brokerage commissions, transaction fees, and other fees to financial intermediaries that you may pay for purchases and sales of ETF shares on the secondary markets.
The gross expense ratio is the fund’s total annual operating expense ratio, gross of any fee waivers or expense reimbursements. The net expense ratio represents the ETF’s expenses after any expenses were waived and/or partially absorbed by the fund manager.
If you invest $10,000 in an ETF with an expense ratio of 0.0945%, you’ll pay $9.45 to the fund’s manager this year. As the value of your investment grows, the amount you pay will also grow — which is why a fund’s expense ratio can significantly impact your returns over time.
Note that expense ratios — which are impacted by many factors, including fund objectives and total assets — vary across the array of available ETFs:
The average expense ratio for index ETFs is typically lower than that of index mutual funds, historically 0.57% for ETFs versus 0.84% for mutual funds.1 Importantly, the higher costs of mutual funds can add up and impact portfolio returns over the long run.
Fortunately for investors, ETFs’ average expense ratios has been falling for many years. From 2009 to 2022, average index equity ETF expense ratios declined by 53% and average index bond ETF expense ratios fell by 56%. In 2022, the average expense ratio for index equity ETFs declined 1 basis point to 0.16%. The average expense ratio for index bond ETFs declined 1 basis point to 0.11% in 2022.2
Many fund company websites and online brokerage platforms offer ETF screener tools to help you sort or filter according to expense ratio. If you’re researching a specific ETF, the expense ratio can be found in a fund’s prospectus or fact sheet.
When considering the cost of an ETF, expense ratio analysis is an important part of the process — but it’s also crucial to evaluate an ETF’s total cost of ownership (TCO), which includes trading and holding costs. Depending on your rebalancing size and frequency, trading costs can accumulate significantly and have a larger impact on TCO than any expense ratio difference between two ETFs.
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1 Morningstar Direct. Data as of March 7, 2023. Average Prospectus Net Expense ratio for index ETFs and open end Index mutual funds as defined by Morningstar.
2 Investment Company Institute, Trends in the Expenses and Fees of Funds 2022, as of March 2023.
Net Asset Value (NAV)
The price of a share determined by the total value of the securities in the underlying portfolio, less any liabilities.
Important Risk Information
This communication is not intended to be an investment recommendation or investment advice and should not be relied upon as such.
Frequent trading of ETFs could significantly increase commissions and other costs, such that they may offset any savings from low fees or costs.
These investments may have difficulty in liquidating an investment position without taking a significant discount from current market value, which can be a significant problem with certain lightly traded securities.
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